Principles of Microeconomics - Taxes

ECON 1051: Principles of Microeconomics - Taxes

Instructor Information

  • Instructor: Andres Cuadros-Meñaca, PhD.

  • Institution: UNI University of Northern Iowa.

  • College: Wilson College of Business

Roadmap

  • Overview of topics related to taxes affecting buyers and sellers.

Objectives

  • By the end of this section, you will be able to:

    • Explain how taxes influence prices and quantities.

    • Describe how the burden of taxes is divided between buyers and sellers.

    • Understand the inefficiencies created by taxes.

Taxes on Buyers and Sellers

  • Tax Incidence Definition:

    • The division of the burden of a tax between the buyer and the seller.

  • Price Structure when a Good is Taxed:

    • When a good is taxed, two prices are created:

    • Price Including Tax: Price that buyers actually pay.

    • Price Excluding Tax: Price that sellers receive after tax is deducted.

    • Buyers respond to the price including tax.

    • Sellers respond to the price excluding tax.

Example of Tax on Smartphones

  • Scenario Analysis:

    • When the government imposes a $10 tax on smartphones, the following changes occur regarding prices and quantities:

    • Initial Conditions (No Tax):

      • Price: $100

      • Quantity Sold: 5,000 smartphones.

    • Post-Tax Conditions:

      1. Demand curve shifts to reflect the tax (D - tax).

      2. Buyer’s price rises to $105 (an increase of $5).

      3. Seller’s price falls to $95 (a decrease of $5).

      4. Quantity demanded decreases to 2,000 smartphones per week.

      5. Total government tax revenue generated is $20,000.

Tax Revenue Collection Illustration

  • Graph Analysis:

    • Price changes after the tax:

    • Buyer now pays $105.

    • Seller receives $95.

    • Tax amount is $10.

    • Quantity sold under tax conditions is considerably lower than without tax.

Tax on Sellers

  • Analysis of Tax Impact on Sellers:

    • This scenario is identical to taxing buyers, with the following observations:

    • Price and quantity outcomes remain consistent, where the buyer pays $105 and the seller receives $95, with a government revenue of $20,000.

Efficiency and Taxes

  • Tax Efficiency Definition:

    • A tax introduces a wedge between the buyer’s price (marginal benefit) and the seller’s price (marginal cost).

  • Outcome of Tax:

    • Equilibrium quantity after tax is less than the efficient quantity, leading to a deadweight loss.

Graphical Representation of Market Efficiency

  • Efficient Market Conditions:

    • Consumer Surplus and Producer Surplus at equilibrium indicates efficiency.

    • Marginal benefit (equivalent to the buyer's price) equals marginal cost (equivalent to the seller's price).

  • Inefficient Market Due to Tax:

    • Deadweight loss represents market inefficiency, indicating reduced welfare due to lower quantity transactions.

Elasticities of Demand and Supply

  • Tax Burden Sharing Based on Elasticities:

    • For Demand:

    • With a given elasticity of supply, buyers pay a larger portion of the tax if demand is more inelastic.

    • For Supply:

    • With a given elasticity of demand, sellers pay a larger share of the tax if supply is more inelastic.

References

  • Gregory Mankiw, Principals of Microeconomics, Tenth Edition, Cengage, 2024.

  • Robin Bade and Michael Parkin, Foundations of Microeconomics, Ninth Edition, Pearson Education Inc., 2021.